We get a lot of questions about the taxes that can impact inheritances, and people are usually surprised when they hear the answers. Believe it or not, you do not have to report an inheritance as taxable income on your federal or state tax returns.
Another positive element to the rules for taxation on bequests is the step-up in basis. The best way to explain this is through the use of a simple example.
Let’s say that your grandfather passes away, and he leaves you 1000 shares of stock that are worth $50 a share. The inheritance is worth $50,000 when you receive it, but he only paid $10 a share 30 years before he passed away.
He paid $10,000 for the stock, so it increased in value by $40,000 while he was holding on to it. If your grandfather would have sold the stock while he was living, the gain would have been subject to the capital gains tax.
Since you get a step-up in basis, this would not apply to you. For capital gains purposes, the present value would be $50,000, and you only be responsible for future gains.
Federal Estate Tax
The next tax we will look at is a mixed bag. There is a federal estate tax in the United States, and on the one hand, the parameters are favorable for most Americans. Your estate would not be subject to this tax unless its value exceeds the amount of the federal estate tax exclusion.
At the present time, the exclusion is $11.58 million. This is the standard figure until and unless legislative changes are enacted, but there are annual adjustments to account for inflation.
There are no taxes on inheritances that are left to spouses, because there is an unlimited marital deduction. It should be noted that this only applies to spouses that are American citizens.
The estate tax exclusion has been portable since 2011, so a surviving spouse could use a deceased spouse’s exclusion.
If you are thinking that a person that is subject to the estate tax could give lifetime gifts to avoid it, you are making a logical assumption. Unfortunately, there is a federal gift tax, and it is unified with the estate tax. Large lifetime gifts that you give reduce the exclusion that will be left to apply to your estate.
Indiana Does Not Have an Estate Tax
A number of states in the union do have state-level estate taxes. The exclusions in these states are typically much lower than the federal exclusion. As a result, someone could be exposed to a state level estate tax even if they are exempt from the federal tax.
We practice in Indiana, and there is no estate tax in our state. However, as we all know, Illinois is just a few miles away. There is a state-level estate tax in the Land of Lincoln, and the exclusion is just $4 million.
If you own valuable property in that state, even if you are technically a resident of Indiana, the Illinois State estate tax could be a factor. Of course, this is true if you have property in a state other than Illinois that has its own estate tax.
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